Columbia Business School

Phone: +1 (212) 854 1276

Publications:

A News-Utility Theory for Inattention and Delegation in Portfolio Choicepdfcode(accepted, Econometrica, 2017) Recent evidence suggests that investors are either inattentive to their portfolios or undertake puzzling rebalancing efforts. This paper develops a life-cycle portfolio-choice model in which the investor experiences loss-averse utility over news and can choose whether or not to look up his portfolio. I obtain three main predictions. First, the investor prefers to ignore and not rebalance his portfolio most of the time to avoid fluctuations in news utility. Such fluctuations cause a first-order decrease in expected utility because the investor dislikes bad news more than he likes good news. Consequently, the investor has a first-order willingness to pay a portfolio manager who rebalances actively on his behalf. Second, if the investor looks up his portfolio himself, he rebalances extensively to enjoy or delay the realization of good or bad news, respectively. Third, the investor would like to commit to being inattentive even more often because it reduces overconsumption. Quantitatively, I structurally estimate the preference parameters by matching participation and stock shares over the life cycle. My parameter estimates are in line with the literature, generate reasonable intervals of inattention, and simultaneously explain consumption and wealth accumulation over the life cycle. Media coverage: Ideas at Work, NY Times, US News, Tim Schaefer media, Think Advisor, CNN money, WirtschaftsBlatt

The Liquid Hand-to-Mouth: Evidence from Personal Finance Management Software (joint with Arna Olafsson)pdfcode(accepted, Review of Financial Studies, 2017)Weuse a very accurate panel of individual spending, income, balances, and credit limits from a financial aggregation app and document significant payday responses of spending to the arrival of both regular and irregular income. These payday responses are clean, robust, and homogeneous for all income and spending categories throughout the income distribution. Spending responses to income are typically explained by households' financial structures: households that hold little or no liquid wealth have to consume hand-to-mouth. However, we find that few individuals hold little or no liquidity and also document that liquidity holdings are much larger than predicted by state-of-the-art models explaining spending responses with liquidity constraints due to illiquid savings. Given that present liquidity constraints do not bind, we analyze whether individuals hold cash cushions to cope with future liquidity constraints. To that end, we analyze cash holding responses to income payments inspired by the corporate finance literature. However, we find that individuals' cash responses are consistent with standard models without illiquid savings and neither present nor future liquidity constraints being frequently binding. Because these models are inconsistent with payday responses, we feel that the evidence suggests the existence of households that spend heuristically and call those the "liquid hand-to-mouth." Media coverage: Ideas at Work, Yahoo!, Finance, Wallethub, MSN Money, MoneyTalks News, Pblcty, Nordic Business Forum, Clark Howard, LostInEconLand

Expectations-Based Reference-Dependent Life-Cycle ConsumptionpdfcodeReview of Economic Studies (2017)This paper incorporates a recent preference specification of expectations-based loss aversion, which has been broadly applied in microeconomics, into a classic macro model to offer a unified explanation for three empirical observations about life-cycle consumption. First, loss aversion rationalizes excess smoothness and sensitivity, the empirical observation that consumption responds to income shocks with a lag. Intuitively, such lagged responses allow the agent to delay painful losses in consumption until his expectations have adjusted. Second, the preferences generate a hump-shaped consumption profile. Early in life, consumption is low due to a first-order precautionary-savings motive. But, as uncertainty resolves over time, this motive becomes dominated by time-inconsistent overconsumption that eventually leads to declining consumption toward the end of life. Third, consumption drops at retirement. Prior to retirement, the agent wants to overconsume his uncertain income before his expectations catch up. Post retirement, however, income is no longer uncertain, so that overconsumption is associated with a certain loss in future consumption. As an empirical contribution, I structurally estimate the preference parameters using life-cycle consumption data. My estimates match those obtained in experiments and other micro studies and generate the degree of excess smoothness observed in macro consumption data.

Expectations-Based Reference-Dependent Preferences and Asset PricingpdfcodeJournal of the European Economic Association (2015)This paper incorporates expectations-based reference-dependent preferences into the canonical Lucas-tree asset-pricing economy. Expectations-based loss aversion increases the equity premium and decreases the consumption-wealth ratio, because uncertain fluctuations in consumption are more painful. Moreover, because unexpected cuts in consumption are particularly painful, the agent wants to postpone such cuts to let his reference point decrease. Thus, even though shocks are i.i.d., loss aversion induces variation in the consumption-wealth ratio, which generates variation in the equity premium, expected returns, and predictability. The level and variation in the equity premium and the predictability in returns match historical moments, but the associated variation in intertemporal substitution motives results in excessive variation in the risk-free rate. This effect can be partially offset with variation in expected consumption growth, heteroskedasticity in consumption growth, or time-variant disaster risk. As a key contribution, I show that the preferences resolve the equity-premium puzzle and simultaneously imply plausible risk attitudes towards small and large wealth bets beyond explaining microeconomic evidence in many other domains.

Under review:

Prospective Gain-Loss Utility: Ordered versus Separated Comparisonpdfcode(revise and resubmit, Journal of Economic Behavior & Organization, 2017)Koszegi and Rabin (2006, 2007) develop a model of expectations-based reference-dependent preferences, in which the agent experiences prospect-theory inspired “gain-loss utility” by comparing his actual consumption to all his previously expected consumption outcomes. Koszegi and Rabin (2009) generalize the static model to a dynamic setting by assuming that the agent experiences both contemporaneous gain-loss utility over present consumption and “prospective” gain-loss utility by comparing his updated to his previous expectations about future consumption. Moreover, the authors generalize the outcome-wise “static comparison” of gain-loss utility to a percentile-wise “ordered comparison,” in which the agent compares expected consumption outcomes at each percentile. This paper generalizes the static comparison slightly differently to, what I call, a “separated comparison.” Under the separated comparison, the agent compares each expected consumption outcome but experiences gain-loss utility only over uncertainty that has been realized, by considering it separately from remaining future uncertainty. This paper shows that the separated comparison yields simple, tractable, and well-behaved equilibria in a wide class of economic models. Moreover, the equilibria are easier to solve for because the separated comparison preserves an outcome-wise linear structure.

Sticking To Your Plan: Empirical Evidence on the Role of Present Bias for Credit Card Debt Paydown(joint with Theresa Kuchler)pdfUsing high-frequency transaction-level income, spending, balances, and credit limits data from an online financial service, we show that many consumers fail to stick to their self-set debt paydown plans and argue that this behavior is best explained by a model of present bias. Theoretically, we show that (i) a present-biased agent's sensitivity of consumption spending to paycheck receipt reflects his or her short-run impatience and that (ii) this sensitivity varies with available resources only for agents who are aware (sophisticated) rather than unaware (naive) of their future impatience. In turn, we classify users in our data accordingly. Consistent with present bias, we find that (i) sophisticated users' average paydown falls with higher measured impatience and that (ii) their planned paydown is more predictive of actual paydown than that of naives. We are the first to provide a theoretically-founded empirical methodology to measure naivete from spending and income data and validate this measure using our information on plans versus actual debt paydown. Moreover, our results highlight the importance of distinguishing between sophisticated and naive present-biased individuals in understanding their financial decision making.

Working papers:

The Retirement-Consumption Puzzle: New Evidence from Personal Finances(joint with Arna Olafsson)clickThis paper uses a detailed panel of individual spending, income, account balances, and credit limits from a personal finance management software provider to investigate how expenditures, liquid savings, and consumer debt change around retirement. The longitudinal nature of our data allows us to estimate individual fixed-effects regressions and thereby control for all selection on time-invariant (un)observables. We provide new evidence on the retirement-consumption puzzle and on whether individuals save adequately for retirement. We find that, upon retirement, individuals reduce their spending in both work-related and leisure categories. However, we feel that it is difficult to tell conclusively whether expenses are work related or not, even with the best data. We thus look at household finances and find that individuals delever upon retirement by reducing consumer debt and increasing liquid savings. We argue that these findings are difficult to rationalize via, for example, work-related expenses. A rational agent would save before retirement because of the expected fall in income, and dissave after retirement, rather than the exact opposite. Additionally, we document the same patterns in commonly used US survey datasets and generate the joint observation of decreasing income and consumption but increasing savings upon retirement in a life-cycle framework with non-standard preferences. Media coverage: MarketWatch

The Ostrich in Us: Selective Attention to Financial Accounts, Income, Spending, and Liquidity(joint with Arna Olafsson)clickA number of theoretical research papers across multiple fields in economics model and analyze attention but direct empirical evidence remains scarce. This paper investigates the determinants of attention to financial accounts using panel data from a financial management software provider containing daily logins, discretionary spending, income, balances, and credit limits. We first explore whether individuals pay attention in response to the arrival of income payments. Here, we utilize that weekends and holidays generate exogenous variation in regular payment arrival using a fixed-effects approach. We find that individuals are considerably more likely to log in because they get paid. Beyond looking at the causal effect of income on attention, we examine how attention depends on individual spending, balances, and credit limits relative to individuals' own histories. We find that attention is decreasing in spending and overdrafts and increasing in cash holdings, savings, and liquidity. Moreover, attention jumps discretely when balances change from negative to positive. We argue that all of our findings are consistent with Ostrich effects and anticipatory utility as the main motivation for paying attention to financial accounts and thus provide new tests for information- or belief-dependent models. Furthermore, we show that some of our findings can be explained by a recent influential one of those models assuming individuals experience utility over news or changes in expectations about consumption (Kőszegi and Rabin, 2009).

FinTech and Financial Fitness in the Information Age(joint with Bruce Carlin and Arna Olafsson)clickWe analyze how FinTech adoption changes the use of high-interest unsecured consumer debt. We employ a Regression Discontinuity in Time approach where we exploit an introduction of a mobile application for financial aggregation platform. We find that with the app introduction individuals accessed information about their finances more often and that this increased attention to their financial accounts reduced interest expenses on consumer debt as well as other bank fees. More specifically, we find that looking at bank account balances one additional time per month reduced consumer debt by 6 percent over a 2-year period for the average indebted individual. We thus document and quantify an effect of increased attention to personal finances on high-interest unsecured consumer debt. These empirical findings help to understand the widespread use of such debt throughout the developed world, which has been a long-standing puzzle in the household-finance literature (Laibson et al., 2000).

Fully Closed: Individual Responses to Realized Capital Gains and Losses(joint with Steffen Meyer)click We use transaction-level data for portfolio holdings and trades as well as account balances, income, and spending of a large sample of retail investors to explore how individuals respond to paper versus realized capital gains and losses. To identify the effects of realized gains and losses, we exploit plausibly exogenous mutual fund liquidations. Specifically, we estimate the marginal propensity to reinvest out of one dollar received from a forced sale event when the investor either achieved a capital gain or a loss relative to his or her initial investment. Theoretically, if individuals held optimized portfolios, the marginal propensity to reinvest out of forced liquidations should be 100% independent of realizing a gain or a loss. Individuals should just reinvest all of their liquidity immediately into a fund with similar characteristics. Empirically, individuals keep a share of their newly found liquidity in cash, save it, consume it, or reinvest it into different funds, stocks, or bonds. Moreover, individuals reinvest 89% if the forced sale resulted in a capital gain, but only 46% in the event of a loss. Such differential treatment of gains and losses is inconsistent with active rebalancing or tax considerations but consistent with mental accounting and the idea that individuals treat realized losses differently from paper losses.

The Consumption Response to Capital Gains: Evidence from Mutual Fund Liquidations(joint with Steffen Meyer and Alessandro Previtero)clickUsing a large sample of transaction-level data on all asset holdings, spending, and income from a German retail bank, this paper explores how individual consumption responds to realized capital gains. Our identification strategy exploits mutual fund closures, which are arguably exogenous to individual characteristics. We estimate the marginal propensity to consume (MPC) out of one dollar received from a forced sale event and find that it is approximately 30%. We explore how the MPC varies in age and income as well as over the business cycle and across interest rate regimes. We find a higher MPC for low-income investors, which appears consistent with standard life-cycle portfolio-choice models, though we do not find any differences in the MPC for young versus old investors. We also find that the MPC to be lower in recessions and decreasing in interest rates, which is surprising from a standard model perspective.

Fresh Air Eases Work – The Effect of Air Quality on Individual Investor Activity(joint with Steffen Meyer)clickThis paper shows that air quality has a significantly negative effect on the willingness of individual investors to sit down, log in, and trade in their brokerage accounts controlling for investor-, weather-, traffic-, and market-specific factors. In perspective, a one standard deviation increase in fine particulate matter leads to the same reduction in the probability of logging in and trading as a one standard deviation increase in sunshine. We document this effect for low levels of pollution that are commonly found throughout the developed world. When individual investor trading is seen as engagement in a cognitively-demanding task similar to office work, our findings suggest that the negative effects of pollution on white-collar productivity may be much more severe than previously thought. To our knowledge, this is the first study to demonstrate a negative impact of pollution on a measure of white-collar work productivity at the individual level in western countries rather than historically polluted places. Media coverage: Washington Post, The Morning Call

Family Finances: Intra-Household Bargaining, Spending, and Financial Structure(joint with Arna Olafsson)clickThis paper aims to test recent influential theories proposing that differences in preferences of household members lead to agency problems reflected in overspending, indebtedness, and financial fee expenses at the household level. To do so, we use comprehensive transaction-level data from individuals within households. Observing individuals within households gives us a unique opportunity to empirically examine how individual revealed preferences over discretionary spending and individual patience affect spending and indebtedness at the household level. To deal with endogeneity, we use a fixed effects and instrumental variable approach, which helps us tackle both self-selection and common-shocks issues. We document that the share of household income received by the spender (impatient) spouse causally increases discretionary (total) spending at the household level, controlling for total household income. Moreover, we find that larger differences in household member patience increase debt and fee expenses at the household level. Our results are consistent with individuals having different preferences over spending and using expensive debt, which results in overspending and indebtedness at the household level.

Expectations-Based Reference-Dependent Consumption and Portfolio Choice: Evidence from the Lab(joint with Thomas Meissner, Philipp Pfeiffer, and Christopher Zeppenfeld) clickIn a lab experiment, we test standard consumption and portfolio choice predictions against those of expectations-based reference-dependent and hyperbolic-discounting preferences. The experiment consists of four periods. In the ﬁrst period, subjects are endowed with experimental wealth. Then, subjects decide how much of their experimental wealth to “consume” by surﬁng the internet instead of performing an alternative monotone task. To consume in future periods, they either store their wealth safely or invest it into a risky lottery. The main predictions of reference-dependent preferences, which stand in contrast to those of standard and hyperbolic-discounting preferences are: First, the consumption share is decreasing in the investment outcome. Intuitively, the agent delays painful cuts in consumption to let his expectations-based reference point decrease. Second, the portfolio share is decreasing in the outcome. The agent increases his risk exposure in bad states to not realize too many loss feelings about future consumption. Third, the agent’s behavior is not time consistent. The agent likes to increase his consumption and risky asset holdings above expectations today, but considers his expectations when making plans about tomorrow.

Starring on a Curve: Are Mutual Fund Managers Responding to Incentives?(joint with Xing Huang)clickNumerous papers provide evidence that actively managed mutual funds underperform passive index funds. However, these papers do not answer the question of whether the mutual fund manager could do better if he had the right incentives or whether he believes in his strategy and wrongly perceives his performance. This paper tries to shed light on mutual fund managers' objectives by examining whether performance responds to changes in incentives. More specifically, we look at a change in the Morningstar rating system from very coarse to very refined categories that happened in 2002. Because Morningstar rates on a curve, the size of the category a mutual fund manager ends up in should have different implications for his incentives or returns to effort depending on whether he is skilled or not. Because Morningstar ratings have the power to move money, this quasi-exogenous variation in a mutual fund manager's incentives should be reflected in his subsequent performance and rating, if he happens to respond and has the ability to improve. Moreover, we look at whether the mutual fund manager tends to improve his performance by eliminating underperformance as opposed to building overperformance.

Payday Borrower's Consumption: Revelation of Self-Control Problems?(joint with Arna Olafsson)clickWe use a new and accurate panel dataset from a financial account aggregation app to analyze the liquidity and consumption of payday borrowers. In line with previous studies, we find that 35% of payday borrowers would be sufficiently liquid to borrow the money less expensively using their credit cards or checking-account overdrafts. Moreover, we do not document large decreases in liquidity before the borrowing event. With respect to consumption, we find that the average borrower uses the payday loan to fund unnecessary and non-durable spending such as alcohol and restaurants. Moreover, we establish a causal link from such spending, as opposed to income, to payday borrowing using weather as an instrument. We argue that these empirical observations help to gauge the welfare consequences of payday lending because they speak in favor of the behavioral view that payday borrowing is caused by self-control problems or misunderstandings about the costs of borrowing and should be regulated.

Monetary Policy Pass-Through to Spending via Consumer Credit(joint with Arna Olafsson)coming soonA recent literature analyzes how households are directly impacted by monetary policy when they hold mortgages with adjustable interest rates, highlighting the income or cash-flow channels of monetary policy. We add to this literature by examining how individuals' spending, saving, and borrowing is affected by monetary policy via variable interest on consumer credit, using very comprehensive panel data from personal finance management software. To deal with endogeneity concerns, we utilize a time series of unexpected monetary policy shocks and individual-level variation as short-term interest rate changes impact individuals differentially when they hold more consumer debt, on credit cards or as overdrafts. Beyond documenting how individuals' spending is affected by changes in their interest rates on consumer credit, we examine how individuals adjust their consumer credit positions. We highlight the role of consumer credit in transmitting the effects of monetary policy in contrast to the existing literature focusing on adjustable-rate mortgages for three reasons. First, in the US, outstanding credit-card debt with variable interest rates is quantitatively more important than adjustable-rate mortgages (which constitute only 2 percent of all mortgage applications currently). Second, holders of adjustable-rate mortgages may not be representative for the overall population. Third, mortgage rates are priced off 10-year Treasury bonds and are thus not only influenced by short-term rates but also the outlook for inflation and long-term economic growth in the US and abroad. In contrast, changes in short-term interest are directly reflected in credit-card interest within one monthly cycle.

Read at your own risk:

When Hurricanes happen: Do Financial Markets perceive Climate Change fully rationally?click How do financial market participants react to frequent and ever more intense occurrences of natural catastrophes that are possible indicators of climate change? The paper tries to approach this question by taking a closer look at the market for cat bonds. Cat bonds are reinsurance devices to transfer risk of The Big One to global financial markets. The market for cat bonds developed in the 1990s after hurricane Andrew seriously questioned the reinsurance capacity of many insurers. In recent years, insurance losses of natural catastrophes have greatly increased, mainly due to people's tendency for dense and distinguished settlement in highly exposed areas of the world. Nonetheless, it remains a niche market mostly restricted to institutional investors, e.g., hedge funds, money managers, or designated cat funds. If the public opinion links weather-related catastrophes to climate change, then specific weather events might be perceived as evidence for global warming. In turn, such events would temporarily influence prices on the cat bond market. I indeed find that major natural catastrophes initiate a movement in prices, which should be absent in efficient markets because investors cannot see the climate's future more clearly through the eyes of specific hurricanes. This reaction of institutional investors to catastrophic news can be prescribed to the law of small numbers, i.e., overinference of small samples, rather than gambler's fallacy effects.

Expectations-Based Loss Aversion: A Micro-Foundation for Stickiness This paper analyzes the dynamic implications of expectations-based reference-dependent preferences in a simple real-business-cycle model. Loss aversion brings about stickiness in consumption. Intuitively, the agent prefers to delay painful cuts in consumption to let his expectations-based reference point decrease. Thus, past shocks predict future changes in consumption. In a general equilibrium model, the agent delays adjustments to consumption by either eating his capital stock or working more. Thus, if labor supply is not perfectly elastic, stickiness in consumption translates into stickiness in wages and predictability in returns and excess returns. Moreover, stickiness in consumption increases the variability of the consumption-wealth ratio and brings its predictability properties in line with the empirical evidence. Finally, as the agent works harder in the event of adverse shocks, hours and productivity might be negatively correlated even if substitution effects outweigh wealth effects in the standard model. The empirically untrue prediction of standard preferences that the agent's short-run labor supply decreases in response to negative technology shocks, has been called the hours-productivity puzzle.

Real Business Cycles, Epstein-Zin Preferences and Non-Existent Equity Premia This research paper addresses the implications of augmenting preferences according to Epstein and Zin (1989) in a standard real business cycle model featuring adjustment costs of capital. In particular, I try to assess the augmented model’s ability to match basic ﬁnancial market moments. Overall, the mere introduction of Epstein-Zin preferences does not help to resolve the equity premium or volatility puzzle. However, the volatility of the stochastic discount factor, the price of risk, is greatly ampliﬁed. This may result in a sizeable equity premium if the model would be extended in a way to increase the quantity of risk. A recently popular approach has been the introduction of long-run risk in the spirit of Bansal and Yaron (2004). In the standard real business cycle model, however, the introduction of a productivity long-run risk component does not appear to tackle the right dynamics in order to stimulate the quantity of risk.

Financial Frictions, Stock Market Boom-Bust Cycles and Monetary Policy (Diplom thesis) This thesis examines the implications of stock market disturbances on macroeconomic variables and monetary policy. In particular, I am interested in so-called stock market boom-bust cycles, scenarios that are characterized by a positive comovement of investment, consumption, equity and stock prices, but followed by a crash that provokes economic depression and a credit crunch. I work with a dynamic stochastic general equilibrium model, which features a nontrivial ﬁnancial sector according to the ﬁnancial accelerator approach of Bernanke, Gertler and Gilchrist (1999), sticky prices, and an inﬂation-targeting monetary policy. I assume that agents suddenly expect high productivity growth in the future which, however, does not manifest in order to generate stock market boom-bust cycles. The central consideration of this paper is the impact of different monetary policy regimes in face of such cycles. I obtain the result that integrating new decision variables, for example, stock market prices, into the conduct of monetary policy improves its performance. Moreover, I ﬁnd that loose monetary policy triggers stock market boom-bust cycles that result from such over-optimistic expectation.